Expansion of Corporate Governance and Government Oversight in the United Kingdom
January 16, 2019
Directors of UK companies will naturally be watching Brexit-related developments with a mixture of trepidation and hope as the United Kingdom draws nearer to a point at which there will be greater clarity on how the legislative framework will look after the March 2019 exit date and beyond (and particularly how it will look after any transitional period expires). The continuing uncertainty around the legislative framework, and the likely focus that all UK companies will have on preparation for the various potential outcomes, should not lead directors to take their eyes off areas of regulatory change where there is already greater clarity. Directors should, for example, be preparing for the raft of UK corporate governance reforms underway and proposals for a strengthened national security and investment regime.
The Expansion and Intensification of Corporate Governance Requirements
Key elements of the corporate governance reform proposals set out by Prime Minister Theresa May’s Conservative government in 2017 came to fruition (or neared fruition) in the latter part of 2018, and directors will feel their effects in 2019 and beyond. The reforms increase both the scope and burden of corporate governance requirements, and, if their ultimate aim is achieved, should help companies achieve even better relationships with investors and other stakeholders.
Revisions to the UK Corporate Governance Code
A revised version of the UK Corporate Governance Code (the “Code”) applies for financial periods that begin on or after January 1, 2019, primarily to companies listed on the premium segment of the London Stock Exchange. Accordingly, the revised Code will affect reporting in 2020, although the relevant governing body is expecting certain changes to have an impact on corporate governance in 2019. Key revisions include new or amended recommendations that have the effect of encouraging companies to:
- have an ongoing dialogue with their shareholders, for example, by recommending that companies (i) disclose what they are going to do in order to understand the underlying reasons behind the opposition if there has been significant dissent (20% or more of votes cast) against a board-recommended shareholder resolution, (ii) report (six months later) on shareholder feedback and (iii) disclose in the annual report the impact of that feedback on the board;
- engage with their workforce by effecting one of the following: appointing a director from the workforce; establishing a workforce advisory panel; designating an existing non-executive director to represent the interests of the workforce; or putting in place other arrangements (provided the company can explain how these arrangements are effective in enhancing workforce engagement). The concept of “workforce” is drawn broadly so that it can encompass, for example, workers on “zero-hour” contracts and also agency workers;
- consider more broadly who their other stakeholders are outside of their shareholders and workforce, and take into account their views so companies can report on the impact of those views;
- shift toward better progression of board chairs by recommending that chairs do not stay on for longer than nine years (including any years served as an independent non-executive director (an “INED”) before becoming chair), subject to a possible grace period to allow for succession planning;
- focus even more on the independence of directors if they fail on one or more of the independence impairment indicators in the Code by guiding companies to give greater detail when reporting on why the board concluded the relevant director was nevertheless independent;
- think harder about the suitability of appointing INEDs with significant other commitments, by recommending companies disclose more about those other commitments, including expected time spent on them and disclosure of why they were permitted; and
- unify their thinking on executive and workforce remuneration by extending the remit of the remuneration committee. In addition to its existing role of determining remuneration for the chair, executive directors and senior management, the remuneration committee should also review (but not determine) workforce remuneration.
Application of Corporate Governance Rules to Large Private Companies
The bulk of UK corporate governance requirements have historically applied only to publicly listed companies. Following a spate of failures of private companies with far-reaching impact, and in recognition of the importance of private companies to the UK economy, the Financial Reporting Council recently published a corporate governance code for large private companies (known as the “Wates Principles”). Broadly, the Wates Principles relate to: (i) the alignment of the company’s purpose with its values, strategy, and culture; (ii) the effectiveness, balance, and size of the board; (iii) the board’s responsibilities; (iv) identifying opportunities and managing risks; (v) sustainable executive remuneration; and (vi) stakeholder engagement and consultation. Companies applying the Wates Principles must clearly explain how their governance practices achieve the outcomes embedded in each of these six principles.
Application of the Wates Principles is voluntary, but may in practice be widely adopted by large private companies as a result of the Companies (Miscellaneous Reporting) Regulations 2018, which became effective on January 1, 2019. These make it mandatory for any company (public or private) with (i) more than 2,000 employees or (ii) turnover of more than £200 million and a balance sheet of more than £2 billion (“large companies”) to disclose which, if any, corporate governance code they apply. Deviations from a corporate governance code or non-application of a corporate governance code must be explained. Unlisted subsidiaries of listed companies can qualify as large companies in their own right.
The new regulations also institute a number of other corporate governance requirements applicable to private companies, including obligations:
- on large companies to describe how the directors have discharged their statutory duty to promote the success of the company for the benefit of its members; and
- on companies with more than 250 UK employees to describe how the directors have engaged with employees and had regard to their interests.
CEO Pay Ratio Reporting
As of January 1, 2019, UK-incorporated companies with over 250 UK employees and shares admitted to the UK Official List, officially listed in the EEA, or admitted to dealing on the NYSE or NASDAQ are required to disclose the ratio of the CEO’s total remuneration to the full-time equivalent remuneration of their UK employees at the median and the 25th and 75th percentiles.